Issue 189 – THE DELAIRE REPORT

23 September, 2015

Gold prices retreated on Monday after a strong rebound last week after the US Federal Reserve announced that it will not be raising interest rates.
In what has become the most highly anticipated meeting of the Federal Open Market Committee (FOMC), the Fed announced that it was going to maintain its current policies, and left the policy rate at 0.125%.

Yet, the accompanying statement and the economic projections came in more dovish than expected. The Fed showed concerns over the negative impacts of the recent global financial market volatility, as well as rapid slowdown in China and other emerging markets, on growth and inflation outlook.

Seven years ago on September 15, 2008, the US government’s total debt was $9.6 trillion. Today it’s over $18 trillion… and once they raise the debt ceiling (which is inevitable) the debt will rise overnight to over $19 trillion– twice as much in seven years.

In 2008 the entirety of the Fed’s balance sheet was just $924 billion. And the total of its reserves and capital amounted to $40 billion, roughly 4.3% of its total assets.

Today the Fed’s balance sheet has exploded to $4.5 trillion, nearly five times as large. Yet its total capital has collapsed to just 1.3% of total assets. And, its assets are things like US government bonds.

Over the last several years the Fed has essentially printed trillions of dollars and which it has used to buy US government bonds. This has all been done at almost zero interest rates. Currently the Fed is holding some $4.5 trillion worth of existing bonds, most of which they purchased when interest rates were basically zero.

So what happens if the Fed raises rates? The market value of their entire bond portfolio will fall.

And given the razor-thin capital the Fed has in reserve, they can only afford a tiny 1.3% loss on their bond portfolio before they too become insolvent.
A new development in the gold market has been India’s attempt to sell gold-backed bonds and allowing banks to tap idle jewellery and bars held by households and temples to cut reliance on imports.

An estimated 20,000 metric tons or more of bullion — more than double holdings in the U.S. — is stashed in India’s homes and temples, according to the government. Modi is looking for a long-term solution to curb gold imports after the current-account deficit widened to a record in 2013 and the rupee slumped to an all-time low.

The monetization plan will allow Indians to deposit their jewellery or bars with banks and earn interest, while the banks will be free to sell the gold to jewellers, thereby boosting supply. The deposits can be for a period of one year to 15 years with the interest on short-term commitments to be decided by the banks and those on long-term deposits by the government in consultation with the central bank.

The plan may fail to draw people in large numbers because of Indians’ inherent love for holding physical gold and low interest rates likely to be offered by the banks. Inadequate banking facilities in rural India, which makes up for 60 percent of physical gold demand, may also scupper the plan, according to the All India Gems & Jewellery Trade Federation.

“The schemes will succeed only if the banks offer interest rates of about 2.5 percent and do not require customers to declare source of deposited gold below a certain limit,”Bachhraj Bamalwa, director of the federation, said by phone from Kolkata. “At the end of the day, Indians’ love for physical gold and investment sentiment in the rural areas, which do not believe in such investment products, will determine the success of the plans.”

It appears that South Africa’s gold mines, the deepest and among the oldest in the world, are in big trouble.

In an article published by Bloomberg, the four largest producers in the country are losing money on about 35 percent of production at current prices. At the same time, higher costs are cutting into profits as electricity bills climb to a record. Workers are also pushing for wage increases, with some threatening to strike if salaries aren’t doubled.

South African output slid at the fastest pace among the 10 biggest-producing countries in the past decade. Mine supply halved in the period to about 145 metric tons last year, according to the World Bureau of Metal Statistics.

The metal has slumped 40 percent from its 2011 record to about $1,122 an ounce. At that price, half of mines owned by the nation’s top producers are losing money, data compiled from second-quarter financial reports show.

Meanwhile on September 11, Reuters reported that gold coin sales in the United States and Europe have surged in the third quarter, with sales from the U.S. Mint reaching levels not seen since the price crash of 2013, as low prices and a series of market shocks fuel retail buying.

Sales of gold American Eagles have nearly trebled year on year in the third quarter with most of September still to go, reaching 322,000 ounces. That’s the highest of any quarter since the gold crash of 2013.

The surge in retail buying in 2013 came on the back of a dramatic reversal in a decade-long rally in gold prices, with buyers scrambling for bargains after a $200 plunge in gold prices in just three days.

The 6 percent drop in prices this year has been less dramatic, but has been accompanied by a highly turbulent period in stock markets, and fears over the stability of the euro zone.

Concerns over slowing Chinese growth flared after the central bank devalued the yuan, knocking Chinese stocks and helping put world shares on track for their biggest quarterly drop in four years. European assets also came under pressure in July from fears that Greece was set to crash out of the euro.

The Austrian Mint, which produces gold and silver Philharmonic coins, said sales of its gold coins more than trebled year on year in July and August to 321,500 ounces, citing lower prices, ultra-low interest rates, stock market volatility and fears of a ‘Grexit’.

The UK’s Royal Mint said it has seen significant increases in Sovereign and Britannia coin sales throughout the past three months, particularly in July. Sales are more than 50 percent higher than during the second quarter, it said.

Degussa, a leading German coin and bar dealer with sales of 700 million euros in the first half of 2015, said its gold sales this quarter have been 30 percent higher year on year.

“We had a fantastic month in July with large coin and bar sales,” Chief Executive Wolfgang Wrzesnioch-Rossbach said. “August was quieter, but still saw 20-30 percent higher demand compared to last year.”

Gold moving through the Exchange this August has totalled a phenomenal 301.96 tons bringing the year to date total to 1,718.2 tons, some 219 tons more at the same time of year than in 2013 when China consumed a record amount of gold.

If SGE withdrawals continue at the average rate recorded so far this year, full year deliveries though the Exchange could reach around 2,580 tons – and this is certainly not an impossibility given that demand during the final quarter of the year usually runs strong. This figure is equivalent on its own to around 80% of global annual new mined supply at present.

However, this robust demand for physical gold has been obscured by the ongoing shenanigans of the bullion banks and their persistent selling of futures contracts on the Comex. For now, the paper or electronic market continues to set the price of the yellow metal creating a distorted perspective of the real situation. But rising premiums and delays for popular bullion products suggests that this continual price suppression will soon give way to a more realistic price discovery reflecting real world supply and demand.

Although silver prices have experienced a tough time in recent times, the white metal got a serious boost last Thursday afternoon after the US Federal Reserve announced that it will not be raising interest rates.

The silver price jumped to an intra-day high of $15.20 per ounce on the news, though it later sank slightly, and now it is back below the $15 an ounce level. Prior to last week, its highest price for the month was $14.80, which it hit on September 8; $14.30, its lowest point came on September 11.

But while Thursday no doubt brought some welcome relief for silver bugs, there’s irrefutable evidence that the global supply of silver is tightening regardless of what the Fed decides to do with its interest rate policy.

The demand for silver coins and bars is stronger than ever, pushing premiums higher of many items, and in some cases causing delays in deliveries
Many bullion brokers are advising dealers who order large quantities of silver products that there is a 2 to 3 month waiting period from ordering date to delivery date. This situation had been going on for several weeks now, and it seems that the shortage of physical silver to last well into 2016. In some cases, some items are just not available at the moment. Lakeshore Trading has struggled to get one ounce silver bars for clients.

In the meantime, total U.S. and Indian silver imports of 391 million oz (Moz) comprised 44% of the total 877 Moz of global mine supply in 2014. However, total silver imports from these two countries are estimated to reach a staggering 533 Moz and consume 63% of total world silver mine supply. Which means, U.S. and India estimated total silver imports in 2015 will absorb nearly 20% more of total mine supply compared to last year.

World mine supply is estimated to be 850 Moz in 2015 versus 877 Moz last year. This is based on falling production from Mexico, Australia, Chile and Canada. However, Australia’s silver production is down a whopping 30% in the first six months compared to the same period last year.

In addition to a decline in mine supply, silver recycling is projected to decline to 178.0 Moz (5,536t) by 2017. This is 14% lower than the 2011 peak, as growth is only expected to average 3% a year, even if prices rally to over $20. This outlook is based on further losses in photographic scrap, a depleted pool of near-market silverware and a limited response from most industrial end-uses.

Silver is at the lowest level over production costs in 10 years. Silver ended August at its lowest price over average cash costs since 2005 (based on data from the CPM group). Silver cash costs (the basic costs of production per unit of output on site) are likely running just under US$9/oz. in 2015, the price of silver ended August less than $6/oz. over the basic cash costs. The year 2005 marked the last time the price of silver sustained a lower price over cash costs, at about US$4/0z. Such a narrow spread over basic cash costs indicates a majority of miners are likely unprofitable which is thus unsustainable in the long term.

Some analysts expect total silver supply to contract in 2015 on the back of slowing mine supply growth and a continued sharp contraction in recycling scrap supply.

So, with falling global silver mine supply on top of declining silver scrap supply, this huge increase of U.S. and Indian silver demand is putting increased stress on the wholesale silver market.

About the author

David Levenstein is a leading expert on investing in precious metals. Although he began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients.

His articles and commentaries on precious metals have been published in dozens of newspapers, publications and websites both locally as well as internationally. He has been a featured guest on numerous radio and TV shows, and is a regular guest on JSE Direct, a premier radio business channel in South Africa. Rand Refineries, the largest gold refinery in the world use his daily and weekly commentaries on gold.

David has lived and worked in Johannesburg, Los Angeles, London, Hong Kong, Bangkok, and Bali.